RBA Cuts Key Rate to Record-Low 2.75% to Combat Aussie: E

Glenn Stevens, governor of the Reserve Bank of Australia, joins counterparts in the U.S., Europe and Japan in cutting interest rates to a record to stimulate demand. Photographer: Patrick Hamilton/Bloomberg

May 7 (Bloomberg) -- The Reserve Bank of Australia cut its
benchmark interest rate to a record low, driving down a currency
that has damaged manufacturing and boosted unemployment.

Governor Glenn Stevens reduced the overnight cash-rate
target by a quarter percentage point to 2.75 percent, saying in
a statement that the Aussie’s record strength “is unusual given
the decline in export prices and interest rates.” Eight of 29
economists predicted the seventh cut in the past 19 months,
while money markets had seen about a 50-50 chance.

“The board has previously noted that the inflation outlook
would afford scope to ease further,” Stevens said. “At today’s
meeting the board decided to use some of that scope. It judged
that a further decline in the cash rate was appropriate to
encourage sustainable growth in the economy.”

He joins global counterparts in embracing record-low rates
in an economy where inflation is contained, mining spending is
predicted to crest, and credit growth remains subdued. Stevens
is aiming to rebalance growth as mining regions in the north and
west thrive and manufacturers in the south and east struggle.

“It’s a seminal decision to put a 2 in front of a decimal
point for interest rates, and the RBA has decided to maintain
its easing bias,” said Joshua Williamson, a senior economist at
Citigroup Inc. in Sydney who predicted today’s decision. “The
currency has been the thorn in their side and the inflation data
was the catalyst to act on the exchange rate concern.”

Currency Reaction

The Australian dollar fell to $1.0199 at 5:19 p.m. in
Sydney, from $1.0238 before the decision. Three-year government
bond yields dropped to as low as 2.47 percent, the least since
Oct. 16. The benchmark S&P/ASX 200 Index pared a loss of as much
as 0.7 percent to close 0.2 percent lower.

The U.S., Europe and Japan have cut rates to a record to
stimulate demand. Federal Reserve Chairman Ben S. Bernanke has
kept the key U.S. rate near zero for more than four years, while
European Central Bank President Mario Draghi yesterday said
policy makers are ready to cut again after reducing its
benchmark to a record low 0.5 percent last week.

The RBA cash rate’s previous low was 2.89 percent in
January 1960, according to the central bank. Australia, which
hasn’t recorded a current account surplus since 1975, typically
maintains higher benchmark interest rates than other developed
economies in order to attract capital inflows to offset its
current account deficit.

Pre-Election Budget

The government will next week hand down its last budget
before elections due Sept. 14, with a deficit of A$14.5 billion
($14.8 billion) expected this fiscal year, according to the
median estimate of 10 economists surveyed by Bloomberg.

The government blames the shortfall on the strength of the
local dollar that is pushing down prices and business profits,
crimping tax revenue. Treasurer Wayne Swan in December abandoned
a pledge to balance the books and says the government is looking
for savings to fund pre-election spending announcements.

“Lower interest rates are playing a very important part in
our economy at the moment, to help us make the transition from
resource-sector growth through to non-mining sector growth,”
Swan told reporters in Canberra today. “The higher dollar is
putting profound pressure on all sectors of the economy,
particularly on the profitability of businesses, and then that
of course flows right through to government revenue.”

Australia’s currency, which didn’t rise above 85 U.S. cents
between 1990 and 2006, hasn’t dropped below that level in almost
three years. Its record 10-month stretch above parity with the
greenback is damping import costs, helping keep inflation below
the middle of the range targeted by the RBA.

Currency Factor

“The exchange rate seems to have been a factor,” said
Dominic Bryant, senior Asia economist for BNP Paribas SA in Hong
Kong who predicted the cut. “The downward move in commodity
prices has finally tested their patience.”

Australia’s economy has been powered by a once-in-a-century
resource investment boom to meet demand in China. The central
bank reiterated today that “with the peak in the level of
resources sector investment likely to occur this year, there is
scope for other areas of demand to grow more strongly over the
next couple of years.”

Traders are betting Stevens will hold rates next month
before cutting the benchmark at least once in the third quarter,
according to data compiled by Bloomberg from interbank
cash-rate futures. The contracts show a 68 percent chance he
will hold at 2.75 percent on June 4, while the September futures
indicate the rate will be 2.5 percent or lower by then.

Europe Data

“It appears that the RBA sees some residual ability to cut
rates again,” Commonwealth Bank of Australia Economist Gareth
Aird said in a research report. “At this stage, a rate cut to
2.5 percent in August following the release of the Q2 CPI would
look the most appropriate time.”

Elsewhere in Asia, consumer prices in the Philippines
increased 2.6 percent in April from a year earlier, less than
economists’ forecast. In Europe, data is expected to show that
German factory orders and French industrial production declined
in March. In the U.S., job openings data for March will be
released.

Australian job advertisements dropped for a second month in
April and the unemployment rate jumped to 5.6 percent in March
as employers shed 36,100 jobs.

General Motors Co.’s Holden division announced last month
it will cut about 500 positions in Australia, saying the local
dollar and currency devaluations in competing markets had made
operations in the nation among the most expensive in the world.

The central bank added to 50 basis points of cuts in late
2011 and another 125 basis points in 2012 as past reductions
have less of an impact than in prior easing cycles.

Slower Reaction

“It is now over 18 months since the RBA started to cut,”
Citigroup said in a May 3 note to clients. “Despite this, only
two of our 12 indicators currently are performing stronger”
than they did when the RBA lowered rates in 2001.

The year-on-year growth in owner-occupied housing loans has
slowed to 3.9 percent, the weakest pace since records began in
1991, according to central bank data.

The rate cut “will provide continued stimulus to
strengthening housing markets,” Andrew Wilson, Sydney-based
senior economist at Australian Property Monitors, said in an e-mailed release. “Lower interest rates and rising home buyer
confidence are set to continue to generate house price growth
although the performance of local economies remains the key.”

National Australia Bank Ltd., Commonwealth Bank and Westpac
Banking Corp. said they will pass along the full interest-rate
cut. Australia & New Zealand Banking Group Ltd. will set rates
on May 10.

Australia recorded its slowest core consumer price growth
in 14 years in the first quarter, government data showed April
24. The central bank’s preferred measure of inflation eased to
0.3 percent from the prior three months.

“Recent data on prices confirm that inflation is
consistent with the target and, if anything, a little lower than
expected,” Stevens said today. “The bank’s forecast remains
that inflation over the next one to two years will be consistent
with the target.”